To incorporate or not? That is one critical decision

Business owners can structure their businesses as a sole proprietorship, a partnership, a corporation, or a limited liability company. Significant tax differences flow from each choice, according to Carman and Smith, a Boca Raton law firm that specializes in business and real estate.

How do you decide which is best for you?

Lawyer Deborah Carman recommends that most clients set up a limited liability company. "It's fairly easy to maintain, protects from individual liability, and you can take tax election as a Subchapter S." When an LLC or a corporation elects to be taxed under Subchapter S, business net income or net loss flows through to the business owner's personal income tax return. "To me, there's no disadvantage to having an LLC," she says.

D. Kerry Jacoby, a certified business analyst with the Small Business Development Center in Boca Raton, agrees. Jacoby teaches business start-up, taxation and accounting classes for the center. Here are Carman and Jacoby's reviews of your options:

SOLE PROPRIETORSHIP

If you are the sole owner of a business, the sole proprietorship form of ownership is simplest. Legally, all the business's assets and liabilities belong directly to the business owner.

Advantages: The owner receives all the profits and makes all the decisions. Net income of the business is taxed only once.

Disadvantages: The owner has unlimited liability for legal problems and debts and is limited in raising capital by her personal resources and ability to borrow money. Also, the net income of the business is subject to Social Security tax, called "self-employment tax" on tax forms. "Sometimes that can be costly," Jacoby says.

PARTNERSHIP

A partnership is an unincorporated business that allows two or more people to share liability and provide capital. There are two types: general partnerships and limited partnerships. In a general partnership, partners share in management and are each 100 percent responsible for the partnership's obligations.

In a limited partnership, there are general and limited partners. General partners manage the partnership and are personally responsible for obligations, while the limited partners cannot participate in management, but share in the profits. Limited partners' liability is limited to the amount of their capital contribution.

Jacoby says the partnership form of business is rarely used these days by small businesses because partners could be held financially responsible for the business actions of other partners. "Partnerships are no longer an acceptable way to conduct business because of these two liability issues," he says.

Advantages: Profits are taxed only once, at the partners' individual income tax rate. Limited partnerships have the ability to raise money without involving outside investors in day-to-day business decisions. Limited partners have limited personal liability.

Disadvantages: Each general partner is fully liable for partnership debts, ownership is difficult to transfer, and the partnership legally and for tax purposes ends upon the death, disability or bankruptcy of any partner.

CORPORATIONS

With a corporation, the exposure to loss is limited to the capital in that corporation. On the downside, there also is a lot of formality and structure involved with corporations, such as holding board meetings, recording meeting minutes, and opening a corporate bank account. Under corporate law, shareholders and officers can be individually sued if corporate formalities are not followed, Carman says.

Jacoby recalls a South Florida restaurant owner who ended up personally liable for everything because the business never acted through the corporation. He didn't transfer the restaurant lease to the corporation, he didn't use the corporate name with vendors, he didn't open a corporate checking account, and he failed to hold board-of-director meetings. "He was running the business as a sole proprietorship."

Corporations with fewer than 75 shareholders can elect to be taxed as an S corporation. The S corporation has the advantage of being taxed only once, through a personal return. That can be helpful in the early years of a start-up when there may be losses.

In a C corporation, the corporation pays income tax on corporate profits -- and shareholders still pay taxes on the profits paid to them.

Corporations are established by filing Articles of Incorporation with the Florida Secretary of State's office. The Division of Corporations then will issue a charter, which establishes the entity.

While Florida law requires only one owner, entities with more then one owner need to have written agreements governing operations, investments, changes in ownership and dissolution of the entity.

Advantages: Liability is limited to one's investment; transferring business ownership might be easier; and it potentially could be easier to raise larger amounts of capital. Carman & Smith says a corporation can be structured to provide tax savings. Self-employment tax can be minimized and allowable deductions can be maximized, lowering the tax on business income.

Disadvantages: There is double taxation with a C corporation. A C corporation pays federal income taxes, and then when the profits are distributed to the shareholders, that same income is taxed again, as dividends, to the individuals. In addition, the corporation must also pay Florida State corporate income tax.

Also, the owner almost always has to sign as guarantor for the entity's financial obligations. And when wearing the hat of an employee or officer, the owner still has unlimited liability for his own actions.

LIMITED LIABILITY COMPANY

An LLC is a legal entity that offers the limited liability advantages of a corporation and, if desired, the pass-through tax advantages of a partnership. Similar to corporations, LLCs are established by filing Articles of Organization with the state's Division of Corporations.

The law protects an LLC member from being held personally liable.

Advantages: The benefits are similar to those for a corporation, except there is a lower bar in terms of corporate formalities, Jacoby says. Operations are governed more by the management agreement than corporate formalities. LLC members enjoy limited personal liability. Also, the owners of an LLC can elect to be taxed as a sole proprietorship, a partnership, a C corporation or an S corporation.

Disadvantages: LLCs are slightly more expensive to form than corporations. Jacoby says since the LLC is a relatively new entity, there still are questions about which state's laws take precedence in interstate lawsuits involving Florida LLCs in different states.

For either a corporation or LLC, there's a potentially money-saving benefit, Jacoby says. After paying a "reasonable compensation" to the active owners, the remainder of the profit is not subject to Social Security tax.